Priceline (NASDAQ:PCLN) is scheduled to announce its results for the fourth quarter and full year 2013 Thursday, February 20. Despite the large size of its business and uncertain global economic conditions, the leading Online Travel Agency (OTA) grew robustly in the first nine months of the year to register top line growth of 29% year over year. This remarkable growth came on the back of a rapidly expanding presence in the international markets and a stronger foothold in the domestic U.S. market. For the fourth quarter, the company has provided guidance for revenue growth in the range of 19% to 26%.
Priceline launched an advertising campaign for its Booking.com site in the U.S. last year. It also invested in building the Kayak.com and the Priceline.com brands. Despite these investments, Priceline’s adjusted EBITDA margin stood at 46% in Q3, approximately the same level as in the year-ago period. Advertising and operating efficiency helped the company to keep its operating margin from falling. However, we note the possibility that it may not be able to maintain its margins at this level in the future, due to increasing competition in the OTA space and falling returns on investments on online advertising.
We will revise our $642 price estimate for Priceline’s stock after the upcoming results are announced.
Strong Growth In International Markets And Acceleration in Domestic Business To Fuel Bookings Growth
Priceline’s stellar growth in recent years has come primarily from its expansion initiatives in international markets. The company posted 42% year-on-year growth in international gross bookings in Q3, as high growth in Asia-Pacific and the Americas boosted hotel room nights by 36% to 75 million, according to its Q3 earnings report, linked above. Booking.com’s dominance over the core European market also contributed significantly. Booking.com is the leading OTA in Europe with 31% share of the market. The brand is now aiming to enhance its presence in Australia and Canada through its Booking.yeah advertising campaign. Priceline is also pursuing aggressive expansion in Asia-Pacific via its Agoda.com brand. These initiatives should help the company to meet its international gross bookings growth target of 29%- 36% for Q4.
While Priceline has successfully gained share in the international markets, it has lost out to Expedia (NASDAQ:EXPE) in the domestic landscape. Priceline has 16% share of the U.S. OTA market, on the other hand Expedia has over 40% share. However, Priceline is taking different routes to increase its share. The company launched its first offline advertising campaign (Booking.yeah) for Booking.com in the U.S. last year. It entered into a partnership with NYC and Co. to power bookings on New York City’s official tourism website. It also completed the acquisition of Kayak. Kayak is the leading meta-search engine in the U.S., with over 50% share of the travel search market.
Domestic bookings account for about 15% of Priceline’s total gross bookings. The company registered 17% year-on-year growth in domestic gross bookings in Q3, its highest in thirteen quarters, and expects to clock 17%–24% growth in Q4. We feel that Priceline’s growing strength in the world’s largest travel market will help offset the slowdown management anticipates owing to the increasingly large size of the business.
High Competition And Heavy Dependence On Agency Model To Put Pressure On Revenue Margins
Hotel bookings account for over 85% of Priceline’s valuation, and therefore, forms the most important division in the company’s portfolio. Priceline’s hotel revenue margins have declined, however, from 39% in 2007 to 21% in 2012. The primary reason for this decreased profitability is the rapid growth in international markets, where the agency model of bookings is more popular. Priceline’s proportion of gross bookings from the agency model stands at over 80%. Revenue margins under the agency model are lower as Priceline simply acts as a travel agent and earns a small commission on bookings, while under the merchant model revenue margins are higher as the transaction is completed on Priceline’s website itself.
Despite the continuous decline since 2007, Priceline’s margins are healthier than that of its closest competitor, Expedia. Priceline does not intend to increase commissions on hotel bookings in order to maintain its competitive position among OTAs. We expect commissions to continue declining due to both, intense competition from other OTAs and supplier websites, and the increasing proportion of bookings coming from emerging markets.
Disclosure: No positions.